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The Bank of Google or Amazon? Don’t count on it

The 2008 movie “WALL-E” imagined a futuristic world in which the megacorporation Buy n Large runs every facet of consumers’ lives. Nine years later, technology has come so far that such a scenario seems conceivable in the real world. Amazon continues to overtake sectors (most recently grocery stores), the tech magnate Elon Musk plans to colonize Mars and just this week the world eagerly heralded the release of another iPhone.

It might seem like it is only a matter of time before the tech giants knock on banking’s door. In fact, a recent World Economic Forum report posited that big tech companies present a greater challenge to banks than fintech startups. The report notes that regulators will accept a more “oligopolistic distribution of financial services products by tech firms.” Already, the fintech providers Social Finance and Square have applied for FDIC-insured banking charters, just as the Office of the Comptroller of the Currency continues work to develop its limited-purpose fintech charter. Are the largest tech firms next in line?

Banks should not be fatalistic about the threats posed by tech companies in financial services, however. Incumbents still hold the upper hand. The risk of an Amazon or Google or Apple dominating the traditional banking sector is nowhere near a slam dunk.

The risk of a giant tech company dominating the traditional banking sector is nowhere near a slam dunk.
Bloomberg News

In every scenario, the tech giants would need to persuade regulators to grant them some kind of charter access in order to effectively compete and level the playing field on funding costs. This would involve easing traditional limits on commercial firms owning banks, and potentially navigating opposition from members of Congress. Remember what happened when Walmart applied for a charter? And even if the tech firms gained entry to banking, they would face new regulatory constraints which would likely curtail their growth in even more important, higher margin core business segments.

But more fundamentally, tech giants have had mixed experiences in rolling out financial services such as Google Wallet and Apple Pay. And despite the reported consumer skepticism of legacy institutions, banks still continue to maintain a high volume of customer relationships.

True, tech barriers to entry into financial services are shrinking. However, barriers around capital, distribution, anti-fraud, security and regulatory requirements are constantly increasing; therefore, the competitive moat for incumbent banks has only been growing.

While the WEF report makes numerous valid points, such as detailing how nonincumbents’ digital customer experiences have raised the bar for what customers expect from their banks, it will take a long time, if ever, for the banking landscape to resemble the highly interconnected, neatly defined ecosystem to which the WEF report’s conclusions lead.

The level of regulatory scrutiny of pricing and marketing tactics, commonplace in financial services, is quite unusual in most other consumer sectors, such as groceries. Unlike what they experience now, large tech companies that may aim to operate banks or offer banklike services would suddenly be forced to comply with a multitude of regulators that would in turn curtail their growth. Many large tech companies have escalated to dominance by maintaining the lowest-cost position. But offering lower-priced financial services, without the large deposit base enjoyed by banking powers, is not as simple as Amazon slashing prices on Whole Foods bananas.

Even through partnerships with banks, big tech companies cannot dodge the associated oversight and regulations with being in financial services. For example, Amazon attempted a partnership with Wells Fargo by marketing private student loans from the San Francisco bank to anyone with an Amazon Prime student account. The program, however, only lasted six weeks before politicians criticized the program for charging higher interest rates and offering fewer repayment options when compared to federal student loan options.

Furthermore, banks have increasingly been partnering with fintech companies to enhance their own digital offerings. As fintech helps banks deepen relationships with their customers, large tech companies may find it even harder to unseat these relationships. Already, the history of tech companies trying to attack banking’s various moats is riddled with cautionary tales. Consider the consumer online lending industry, for example. Problems facing Lending Club and Prosper Marketplace have been well documented. Despite the marketplace lenders’ supposed advanced technology, a decade of low interest rates and pristine consumer credit across the entire lending industry, both companies have struggled to find a way to turn a profit.

More recently, the disruption hype has been surrounding tech companies that are “displacing” banks in underwriting business loans. Case in point, an op-ed, “Another industry Amazon plans to crush is small-business lending,” appeared on CNBC this summer. While this op-ed and others have touted the momentum of OnDeck, Square and Amazon, in reality, their total volume of originations pale in comparison to larger banks. Certainly, Amazon has had some success — lending more than $3 billion to 20,000 small businesses in the U.S., U.K. and Japan on the Amazon marketplace since 2011. Since launching in 2014, payment processor Square has also lent more than $1.5 billion — which also sounds like a large number until you compare it to JPMorgan Chase, which has provided more than $130 billion to small businesses since 2011.

Is large tech luring customers away from banks, or is it targeting a different business? Volumes are small, the offerings are niche, and the terms are often demanding. At Amazon, borrowers must be invited, and Amazon has access to future sales revenue and inventory should borrowers not pay the loans back. We suspect many of the borrowers who turn to Amazon for loans are not business customers that banks would want to serve. The ideal bank customer is a business that needs a sizable loan or has longer-term funding needs — for which banks can offer more attractive interest rates because of their ability to fund and service the loans at a lower cost, while cross-selling multiple deposit and credit products. So while Amazon and others are bringing capital to an underserved market, their business strategies are still a far cry from an existing industry being “crushed” by a tech giant.

Given the impressive growth rate of many of the largest technology companies, it simply doesn’t make financial sense to stymie that growth in order to enter a commoditized industry like lending or deposit-gathering that has not produced great return on equity over the last decade. And past efforts by major consumer retail conglomerates to enter financial services could be an omen for tech firms with similar ambitions. Between 1998 and 2007, Walmart attempted to obtain an FDIC-insured banking license several times. Eventually, the retailer had to back out due to the associated regulatory and political challenges. Home Depot’s pursuit of a charter met a similar fate.

The bottom line? Although the headlines surrounding the WEF report paint an inevitable picture of a Silicon Valley-dominated banking industry, such a scenario actually playing out is less likely. The future of how big tech coexists with banking will more likely reside in co-opetition versus disruption.

The specialized products and services that are coming out of many upstart fintech firms are having the most impact on the industry by adding value to the existing financial ecosystem — mobile banking, faster payments and streamlined lending processes, to name a few. While the process of paying back a loan will never be as fun as online shopping, we expect the value-added services of these fintech companies to meaningfully enhance the banking experience in the years to come. We also may see closer alignment between financial institutions and large tech companies again to enhance the incumbents’ offerings.

So despite all the hype, rest assured — by no means will the Bank of Amazon or Bank of Google be taking direct deposits to finance the apartment complex next door anytime soon.

Regarding the specific borrowing segments that Amazon and Square are now serving, keep in mind that many disruptors start in a particular niche, build a market, then extend into other broad segments. Desktop printer manufacturers, for example, started with home offices, now dominate the printer market.

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